I. Development and Governmental Issues
Depending on the nature and location of the property, an investor's plans for the property, and the
governmental climate, the investor needs to answer the following questions, as well as others driven by local
issues and concerns. If the transaction contemplates any development or redevelopment at all, the matters
listed here are often potential ``showstoppers."
Approvals. Requirements to obtain governmental approvals, or at least make filings, under a wide range of
laws. Development approvals are only the tip of the iceberg. A transaction may require approvals under laws
governing such matters as antitrust, health care, housing, liquor licensing, or operating matters generally.
These requirements are particularly likely for multisite quasi-operating-company transactions. They will vary
widely depending on the existing and intended use of the property, as well as the size of the transaction and of
the parties.
Landmarks. Landmarks status of the property, and other similar restrictions on development or redevelopment,
such as historic preservation issues and recorded development restrictions (also part of the title review
process).
Licensing. Requirements for licenses and permits, and resolution of any missing items. Any changes in such
requirements that might result from the transaction. Are the licenses transferable? Operating licenses, such as
those for liquor, health care facilities, gaming, and the like, may raise issues that go beyond the property to be
acquired. Because they often involve some degree of governmental discretion, transfers of these licenses
introduce an element of randomness, unpredictability, and hence risk that the contract must allocate between
the parties.
Miscellaneous Agreements. Any agreements with governmental authorities, whether or not recorded.
Plaza Agreements. Public plaza agreements, particularly for issues relating to income, maintenance,
operations, and repairs.
Public Areas. To the extent that seller owns any areas that are open to the public generally, any measures
that seller has taken to prevent the public from obtaining a ``prescriptive easement" or other impairment of
seller's title.
Transportation. Agreements and arrangements relating to transportation, either benefiting the property or
restricting its use. These might involve, for example, subway tracks and stations, rail spurs, pipelines, and
tunnels.
Zoning. Zoning analysis, including compliance, appeal rights, and availability of unused development rights,
possibly culminating in a zoning opinion or advice memo. Necessity for any variance, special permit, or other
dispensation. Any restrictions on the transferability of these benefits.
II. Legal Due Diligence (General)
At the beginning of any transaction, investor may want to have its counsel receive and review copies of at least
the following documents regarding the property.
Brokerage. Any agreements or understandings regarding payment of brokerage commissions for the
transaction now contemplated.
Condominium or REA. If the project is structured as a condominium or under a reciprocal easement agreement
structure, then copies of all relevant documents, including minutes of Board of Managers or other board
meetings.
Contracts. Service contracts (elevators, security, alarms, etc.). The level of review will vary depending on
whether the contracts are cancellable, require termination payments, or are particularly important, unusual, or
hard to replace.
Employees. List of employees, length of employment, salary, fringe benefits and vacation, together with any
labor union contracts and agreements with any nonunion building employees.
Ground Leases. If the property is held as a leasehold, copies of the lease, any amendments, previously issued
estoppel certificates, and any correspondence with the lessor.
Leases. Space leases, including any leases and lease amendments under negotiation or to be signed during
the closing process. Scope of review will vary depending on the size and composition of the leases and the
transaction structure.
Litigation. Pending litigation may affect seller, any of its constituent entities, or the property itself—but the
inquiry may need to go beyond those three obvious categories. For example, litigation about nearby
environmental matters, entitlements, governmental disputes, Native American land claims, or other similar
matters may indirectly affect a large development project being acquired. Any such litigation might not name
the seller as a party and might not specifically relate to the property. Discovery of problems like this often
requires local advisors at ground level.
Management Agreement. Management agreements.
Other Buildings. Agreements with neighboring property owners that tie this real property to any other real
property for utilities, infrastructure, services, access, support, parking, roadways, operations and maintenance,
or any other purpose.
Pending Construction. Description of pending construction for both tenant improvements and any building-
wide capital improvements, including contracts, budget, status, and anticipated timing.
Telecommunications. Agreements with telecommunications or internet service providers.
Utilities. Utilities agreements.
III. Legal Due Diligence (Lease-Related)
Because rental income usually drives real estate value, and because leases and tenancies often conceal
surprises, it is not enough for the investor or their lawyer to simply read the leases. One must look behind the
leases, by asking for information such as the following.
Abstracts. Abstracts of the existing leases, including any in seller's possession or prepared by seller's advisors.
Antenna Leases. Antenna and other telecommunications leases, particularly to review for termination rights
and nonexclusivity.
Brokerage. Any leasing brokerage agreements that will stay in place after the closing. Amount and timing of
any outstanding commission obligations for any leases previously signed or now being negotiated.
Correspondence. Correspondence with tenants regarding defaults, administration, etc.
Disputes. Pending disputes with tenants and eviction actions.
Estoppel Certificates. Although primarily an issue for the closing, investor's due diligence may help identify
timing problems with obtaining estoppels and any terms of tenants' leases that relate to or limit the delivery of
estoppel certificates. When estoppel certificates are delivered for the closing, investor's due diligence would
also include review of those estoppel certificates to identify and understand any problems or issues they
disclose.
Guaranties. Existence, status, and strength of guarantors.
Rent Roll(s). Spreadsheets showing all tenants, rents, escalations, commencement dates/expiration dates,
option terms, security deposits, and tenant status.
Security Deposits. Security deposits, including letters of credit or other forms of cash and cash equivalents.
Transition arrangements.
Stacking and Options. Stacking plan, now and in the future, including future interaction of all expansion,
contraction, and renewal options.
Standard Lease. Standard form of lease, on paper and in machine readable format, including all exhibits (such
as alteration rules, building rules, design criteria).
Tenant Financing. If the landlord gave any tenants financing for their tenant improvements, then copies of all
loan documents and information about the status of these loans.
Transfers. Any assignments, assumptions, and subleases.
IV. Searches and Survey
The public records and other sources will provide a great deal of crucial information about the property.
Investor or its counsel may want to investigate and review at least the following items.
Certificate of Occupancy. Certificates of occupancy covering the entire building, or an explanation. Status
and expiration dates for any temporary certificates of occupancy.
Designated Areas. Status of property regarding ``flood plain," ``wetlands," other designated areas.
Miscellaneous. Liens, judgments, bankruptcies—both for seller and for any major tenants.
Municipals. Searches of municipal departments for violations, fines, licensing problems, unpaid utility charges,
and similar matters.
Survey. New survey or update of existing survey, and certification to all necessary parties. Compliance with
lender's survey criteria. Comparison of the survey against the appraisal or the larger transaction, if any
uncertainty or difficulty exists regarding the scope of the property (such as future development parcels or a
vertical subdivision).
Title. Opening of title insurance orders, including strategic placement of title work. Title search, including
obtaining and reviewing copies of all underlying documents and assessing how each will affect future use and
development of the property.
UCC. Uniform Commercial Code and similar filings against seller and potentially other parties.
V. Financial Due Diligence
To check out the financial strength of the property, investor should not only look at the leases and lease-
related information as described above, but also several other categories of information, including those listed
below and the tax-related issues covered later in this article.
Appraisal. Third-party analysis and valuation reflecting the current market.
Audit. Audit of operating and other expenses. The intensity and nature of this audit may vary with
circumstances.
Brokerage Commissions Due. Future payments of brokerage commission for existing leases already in place.
Budgets. Operating budget for the current year. Seller's budget for capital projects, or anticipated schedule of
requirements.
Financial Reports. Property financial statements for the last several years.
Insurance. Analysis of future insurance coverage requirements and likely cost, including a comparison with
seller's cost of insurance.
Operating Expense Changes. Possible changes in operating expenses after the change of ownership.
Percentage Rent. Sales reports from percentage rent tenants.
Receivables. Amount, composition, and implications of seller's receivables from tenants (part of rent roll
analysis).
Service Contract Costs. Analysis of the cost of service contracts and possible alternatives after the change of
ownership.
Staffing. Employee roster and compensation. Future staffing changes for building. Impact of union contracts,
if any.
Tax Returns. Review of seller's tax returns and underlying schedules; comparison against other financial
reports and information.
Tenants. Analysis of financial condition of tenants (particularly major tenants) and their financial statements, if
available.
VI. Physical Due Diligence
The investor will typically retain outside engineers and other consultants to examine the physical condition of
the property, including the following characteristics.
Archeological. Prior uses or ownership that may create archeological issues and interfere with or delay future
development.
Artwork. Existence of any murals or other built-in sculpture or artwork, triggering possible artists' rights
restrictions under applicable law. Scope of any artwork included in the transaction. Ownership of that artwork.
Code. Compliance with building, fire, zoning, and other codes (including Americans with Disabilities Act).
Particular focus on issues of parking; the possibility of new environmental or energy conservation requirements;
life and fire safety systems; earthquake compliance and seismic safety; and retrofitting requirements.
Engineering. Engineering issues, particularly for the structure and major systems of the building. Analysis of
the age and condition of building systems, façade, windows, and other components.
Environmental. Environmental and asbestos analysis, including ``Phase I" report and, where indicated,
``Phase II" report. Updating of any existing reports as necessary. Identification and status of any underground
storage tanks. Investigation of any new environmental concerns of the moment, such as ``sick building,"
electromagnetic fields, poisonous insulation, other ``problem" building materials. Notices or claims regarding
environmental matters. Application of any state-specific environmental review procedures (e.g., New York State
Environmental Quality Review Act).
Geotechnical. Soils analysis and report.
Local neighborhood. Compatibility with nearby uses, and likelihood of objections to any future Operations at
the property or potential change of use.
Measurement. Measurement of actual usable and rentable size of the building.
Operational Audit. Complete audit of building operations.
Pending Construction. Identify and deal with any pending construction work (capital or tenant related).
Identify status of job and cost to complete.
Plans and Specifications. As-built plans and specifications.
Power. Adequacy of electrical service and availability of more power and/or competitive power. Availability of
space for any new equipment that may be needed.
Telecommunications. Access to and availability of additional telecommunications services, such as fiber optics
and other data links.
Tour. Building tour, including mechanical areas.
Upgrades. Identify any necessary building system upgrades (more telecommunications, generators, fuel tanks,
rooftop facilities, etc.) and their feasibility.
Utilities. Adequacy of utilities, availability of any desired upgrades, physical connection arrangements, and any
necessary changes.
VII. Tax Issues
Like any other business transaction, any real estate transaction may require consideration of a wide range of
taxes, affecting both the asset and the structuring and closing of the transaction. Those taxes and related
issues may include the following.
Local Variations. Tax issues are particularly likely to vary from place to place. Investor may require local
advisors even at the earliest stages of the transaction.
Mortgage Recording Tax Savings. Availability of existing mortgages (including from any other property) for
assignment to new lender to save mortgage recording tax in any jurisdiction with such a tax.
Real Estate Taxes, Generally. Status of real estate tax protests and any likely or built-in increases in real
estate taxes during the coming years. Copies of actual real estate tax bills for the entire property for the last
three years. Agreements with attorneys hired to prosecute any real estate tax protests.
Real Estate Tax Assessments. Likelihood of upcoming reassessments.
Subsidized Financing. Existence and terms of any tax-exempt or other government subsidized financing
affecting the property; any restrictions on the proposed transaction.
Tax Abatements. Availability (or continued availability) of any tax abatement or incentive programs, and
requirements to qualify, including timing.
Tax Lots. Alignment of tax lot lines with property lines.
Tax Planning. Tax planning, both for acquisition and initial structuring to facilitate favorable future operation
and disposition.
Transfer Taxes. Calculate, minimize, and allocate, taking into account local law and practice.
VIII. Contract Issues
As the due diligence discloses the exact scope of the asset and any problems with it, each piece of information
will affect what the larger transaction should require of other parties both before and at the closing, and the
investor's negotiation of the documents that will govern the transaction. That process, and negotiations
generally, will force the investor to consider at least the following issues.
Amenities. Identify any facilities or services benefiting the property, understand ownership structure.
Attachments. Identify exhibits and schedules to be attached, both schedules to better describe the asset (lists
of contracts, leases, etc.) and exhibits setting forth the form of closing documents. Develop and review all such
attachments.
Closing Arrangements. Plan ahead for closing documents, deliveries, and events, including such matters as
requirements for estoppel certificates and nondisturbance agreements; termination of service contracts;
satisfying lender's closing requirements.
Contract Issues. Wide range of contract issues, including the due diligence process itself; amount of contract
deposit and use of letter of credit; representations and warranties and their survival and credit support;
assignment of any existing mortgages to new lender; responsibility for costs arising from the transaction
(termination fees under service contracts, severance, transaction costs, etc.); allocation of transfer taxes;
survival of representations and warranties; interim operations between contract and closing; responsibility for
pending construction; prorations (including timing and seasonality of percentage rent); and numerous other
issues, including any that arise from the due diligence process.
Coordination. If this transaction involves other transactions, coordination of multiple simultaneous closings,
exchange arrangements, or other linkages.
Memorandum of Contract. Record memorandum of contract?
Publicity; Etc. Publicity and confidentiality.
Recognition. If the property is subject to any existing mortgages, possible agreements with the holders of
those mortgages to protect a purchaser's rights.
IX. Other
The specific investor's agenda and plans for the building may produce another set of issues, many of a very
practical nature.
Approvals. Internal approval requirements and timing for each investor in the transaction, including any indirect
participants. Third-party approval requirements for the proposed transaction and investor's subsequent plans
for the asset.
Broader Picture. Any broader trends—not tied to the particular property—that may indirectly affect the
success of this property. Demographics, the local economy, political trends, labor problems, and other
background issues that may be difficult to identify, particularly for an investor that does not team up with a local
partner, advisor, or consultant. What local changes are likely in coming years? Growth restrictions?
Rezoning? New development?
Business Strategy and Flexibility. Identify purchaser's business strategy for any changes in the building -
physical reconfiguration or renovation, legal structure, new amenities, circulation patterns, parking, change of
use, operational, name of building, etc. Determine whether any impediments exist to those changes (see
above). Analysis of cost, timing, financing, and feasibility for any changes.
Engagement Letters. If investor hires outside contractors for due diligence or other pre-closing work,
engagement letters with those contractors. Reliance letters in favor of lender.
Insurance Recommendations. Correspondence and recommendations from insurance carriers.
Management Files. Review of management files for possible claims, disputes, physical issues, other
problems. Copies of any reports, recommendations, or projections made by management company or
department.
Management Transition. Plan for transition of management, including obtaining files and machine-readable
databases and project management information. Possible retention of building management team or selected
employees.
Market. Market study, including projection of rents and vacancy, pending construction, likely future
construction.
Marketing Materials. Brochures, plans, marketing materials.
New Entities. Naming and formation of new entities; name reservations, and availability.
New Loan. Closing documents, deliveries, planning, and negotiation for new financing.
New Ownership/Debt Structure. Establish, structure, and negotiate debt and equity structure for new
ownership. Consider business terms, regulatory and tax structure, exit strategy, internal flexibility, agenda of
multiple partners, control, ownership, management, etc. (These structuring issues and possible ways to
approach them are outside the scope of this article.)
Publicity. Press release (if any) and publicity, or prevention of same.
Research. Research seller's acquisition cost. General research in Nexis or the Internet regarding publicity on
the building and seller.
Unique Concerns. Any special nonstandard considerations or agenda items of a particular investor (``feng
shui," workforce requirements, etc.).
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